Years ago, I found myself sitting in law school in Moot Court wearing an oversized itchy blue suit. It was a horrible experience. In a desperate attempt to avoid anything like that in the future I enrolled in a tax course. I loved it. I signed up for another. Before I knew it, in addition to my JD, I had a LL.M Taxation. I needed only to don my cape…. taxgirl® was born. Today, I live and work in Philadelphia, PA, one of the best cities in the world (I can't even complain about the sports teams these days). I landed in the City of Brotherly Love by way of Temple University School of Law. While at law school, I interned at the estates attorney division of the IRS. At IRS, I participated in the review and audit of federal estate tax returns. I even took the lead on a successful audit. At audit, opposing counsel read my report, looked at his file and said, “Gentlemen, she’s exactly right.” I nearly fainted. It was a short jump from there to practicing, teaching, writing and breathing tax.

Tax Court Sides With IRS In Tax Treatment Of Frequent Flyer Miles Issued By Citibank

It used to be that when you opened a new account at a bank or other financial institution, you got a free pen. Or, if the bank was feeling really flush, a toaster.

These days, however, banks are wooing customers with more valuable incentives like frequent flyer points. Those incentives now come with a price: the Tax Court has sided with the Internal Revenue Service (IRS) in attempts to tax the value of an airline ticket redeemed with “Thank You Points” from opening an account with Citibank.

Citibank, of course, brought this on itself. You may recall that, in 2012, Citibank announced that it would issue a form 1099-MISCMISC for those customers who receive frequent flyer miles – called “Thank You Points” – for opening accounts. Citibank allegedly didn’t make this disclosure to its customers at first (in 2011, their promotional materials contained the helpful line, “Customer is responsible for taxes, if any.”) Nor did it print the value of the miles on its promotional materials. The announcement after the fact triggered a class action lawsuit against Citibank alleging that the banking giant failed to adequately notify customers of the potential tax consequences and further, that Citibank inflated the value of the miles for purposes of issuing the tax forms. Sen. Sherrod Brown (D-OH) even sent Citibank a letter asking them to stop sending “unnecessary forms” to taxpayers.

Not all banks agreed with Citibank’s position. When Citibank announced the practice in 2012, American ExpressAmerican Express explained that they treat the miles more like a rebate – just as the airlines do (those miles are generally considered nontaxable).

Tax pros also weighed in on the matter, most coming down on the side of “not taxable” with many saying that the issue would not have even been raised if not for the issuance of the form 1099-MISC by Citibank. Not reporting the income once it’s been deemed income by Citibank could result in an audit.

While these debates were going on, the IRS remained curiously quiet. The IRS position since 2002 (announcement downloads as a pdf) has been that frequent flyer miles earned due to business travel are not taxable. The IRS has taken the position that it “will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.” The notice went on to say that, with respect to promotional benefits, “the IRS has not pursued a tax enforcement program with respect to promotional benefits such as frequent flyer miles.”

Until now. Thanks, Citibank.

(Photo credit: Wikipedia)

In Shankar v. Commissioner (downloads as a pdf), decided earlier this week, Citibank issued a form 1099-MISC to the taxpayer in the amount of $668 for redeeming “Thank You Points” for an airline ticket. Citibank supported the IRS position at trial by providing an affidavit confirming the amount of the ticket.

Thankfully, the Tax Court did draw a distinction between the taxability of “Thank You Points” and frequent flyer miles attributable to business or official travel using Announcement 2002-18 (linked above), wherein the IRS made clear that they would not tax frequent flyer miles attributable to business travel. But that’s where the good news for taxpayers stopped.

In a case of what could be characterized as bad facts making bad law, taxpayers didn’t put up much of an argument for not including the income on the tax return: there was no lengthy brief explaining why it might be excludable. Nor did the IRS say much about the inclusion: they more or less took the position that Citibank’s form was enough to prove income, triggering the Tax Court to decide that “we give more weight to Citibank’s records.” The Tax Court then, had to “proceed on the assumption” that the points were a premium for a deposit. Under section 61(a)(4), then, they reasoned, it would be considered gross income. Section 61(a) defines gross income to mean “all income from whatever source derived” including a list of specifically taxable items. Subsection (a)(4) is just one word on that list: interest. The Tax Court’s reasoning, then, seems to be that Citibank classified the “Thank You Points” as interest saying that it was “something given in exchange for the use (deposit) of [taxpayer's] money.”

I think that’s a bad result. I also think that Tax Court was backed into a corner with an overly aggressive initial interpretation of the law by Citibank which, it should be noted, made the issue an issue before IRS or Tax Court had taken an official position.

The entire discussion of whether to include the 1099-MISC as income took up just three paragraphs of the opinion. As a result, I don’t expect the entire issue to be settled with this ruling. Notwithstanding that I don’t agree with the result, I think the finding raises potentially more confusing issues for taxpayers, including what happens when/if the points expire. If the points are included as income and later expire, would that be a nontaxable event – or would the inability to use them result in some sort of loss? I also find it somewhat unclear from the ruling whether the tax trigger should be the issuance of the points – which would support the interest argument – or the redemption of the points for a ticket.

For the record, when I first wrote about this in 2012, Citibank contacted my editor to talk about the story. They weren’t too happy about my characterization of what they were doing. They really, really wanted me to emphasize the part of the IRS position that the miles “can be a taxable situation.” Emphasis on “can.” It was almost as if the bank wanted the miles to be taxable, a position that I questioned, writing, “I remain perplexed as to why Citibank chose to make this an issue with taxpayers and IRS when the IRS has been very clear since the 2002 Notice that it will not aggressively pursue these matters if they do not appear to be abusive. If you have additional commentary for my story, I am happy to include it.” In response, Citibank did not offer additional information, merely pointing me to the Notice I previously cited in my piece and then following up with a statement from CCH where the IRS stated, “When frequent flyer miles are provided as a premium for opening a financial account, it can be a taxable situation subject to reporting under current law.” Emphasis on “can.”

I’m sure Citibank feels vindicated by the ruling. I have to wonder, however, how their customers feel.

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10% income tax on any type of income (individual, business, corporate, capital gains, etc.) with first $30,000 exempt per individual – no other deductions beyond business expenses., i.e. married couples (gay or straight) would exempt $60,000 – no marriage discrimination.

10% national sales tax with every tax filer getting up to $3,000 check from gov’t to exempt up to 1st $30,000 (based on previous year filed taxed return). The unreported cash economy is huge!

10% net worth tax on individual assets above $1.1 billion including charities owned/controlled by an individual (they build themselves buildings and put their art collections in them with lavish perks for themselves.) Now that is progressive! So Bill Gates has personal NW of $54 billion plus controls his charity of $25 billion, so he would owe a tax of $7.9 billion on his $79 billion. Every year until he gets to $1.1 billion! Warren Buffet said that once you reach $500 million in NW there is pretty much nothing you can’t buy. With the exemption of $1.1 billion Bill Gates and the like will still have plenty of NW left to rule the world! Think of it like property taxes on your house.

Sounds pretty simple until you try to determine “income’. W-2 income is easy but what about a business? Do they get a deduction for cost of goods sold? Does it make a difference if you sell pencils or sell houses? What if I have to buy a $1 million “pencil making machine”? OK there are some deductions. What if you inherit your dads farm and the land is worth $11 million? Etc etc page by page the code is built.

I respectfully disagree with you. The Form 1099 is a way for the company to document an expense. As a form of compensation under section 61, there is a corresponding expense to the issuer company. That is tax law #101. Of course we do not know the amount of expense claimed by the issuer. The amount of the income received would be nominal. I think the IRS is following a “de minimus” rule because of the nominal value. In the aggregate, the issuer who have a large expense deduction for federal income tax purposes.

Alvin, are you taking the position that you can’t claim an expense if not substantiated by a form 1099?

Additionally, I don’t know that I agree that the value of the income to taxpayer (the ticket) is the actual expense to the company. I would be surprised to find that American Airlines (or the specific airline involved) is marketing the ticket for the exact value cited by Citibank. In fact, Citibank has been accused (see the 2012 article) of inflating those values on the 1099 – though the Tax Court clearly didn’t find that to be the case here.

Very true indeed- There are two sides in issuing a 1099, income for one but an expense for the other. I agree that in issuing the 1099 Citibank was verifying an expense. The de minimus rule may apply to a toaster but not to frequent flier miles worth over $600 in value.

Agree completely Kelly. Even IF Citibank paid that much to American for the miles (and I find that highly unlikely), the value of the miles to the CARDHOLDER is what they either sell for on the market (buy/gift on AA.com) or the value of the flight they got used on. The concept that that the 1099 reporting is not only mandated but that the income shown reflects a correspondingly equal EXPENSE for the issuer is patently FALSE. This wasn’t a cash payment. Its no different than someone getting a 1099-MISC for the value of a car won in a raffle. Almost assuredly the 1099 shows MSRP of the car. Well the fair market value of the car won’t be MSRP, and its a pretty good bet the issuer of the 1099 didn’t have an expense in that amount either.

David no one is claiming an EQUAL expense for the issuer. The FACT is that a Form 1099 Misc is due on payments over $600. Once the $600 threshold is met a 1099 is issued. Most probably the 1099 is issued by a computer program automatically. The deduction taken may well be different after discounts are applied or whatever.

Bill, actually someone on this very thread claimed just that. From Alvin S. Brown, Esq. “The Form 1099 is a way for the company to document an expense. As a form of compensation under section 61, there is a corresponding expense to the issuer company. That is tax law #101.”

This is wholly incorrect. I would also point out that the actual FMV of the miles themselves should be in dispute as Kelly points out in her column. The same number of miles could be used on a very wide range of flights with very different fare prices. Since most RT coach flights in the continental US are under $600 on American on any flight booked a couple weeks in advance, I have a hard time seeing where the 1099 threshold is met. You’ll note that the case doesn’t ask Citibank HOW they determined the value of 50k miles.

I’m with Alvin here, every 1099 I issue in my company is a direct deduction off of my income. Now I’m not Citibank, I’m a small business owner. I can say with a doubt as a business owner this is a tax deduction for Citibank disguised with fancy marketing, directed toward standard consumers that know nothing tax laws.

John, I appreciate that not all businesses are Citibank-sized but there are plenty of examples of deductions that do not result in a corresponding 1099. You don’t, for example, issue forms 1099-MISC to corporations (with a few exceptions) or for transactions paid by credit card (those might end up on a form 1099-K). Of course, you don’t issue them for transactions under $600. And on and on. Just as not receiving a form 1099-MISC doesn’t exempt you from reporting income on a return, not issuing one does not always result in the loss of a deduction.